280  Forecasting Performance
issued debt: accounts payable ($24 million), short-term debt ($178 million), 
long-term debt ($80 million), and shareholders’ equity ($227.6 million) total 
$509.6 million. Because liabilities and equity (excluding newly issued debt) 
are greater than assets (excluding excess cash), newly issued debt is set to 
zero. Now total liabilities and equity equal $509.6 million. To ensure that the 
balance sheet balances, we set the only remaining item, excess cash, equal 
to $49.6 million. This increases total assets to $509.6 million, and the balance 
sheet is complete.
To implement this procedure in a spreadsheet, use the spreadsheet’s 
prebuilt If function. Set up the function so it sets excess cash to zero when 
assets (excluding excess cash) exceed liabilities and equity (excluding 
newly issued debt). Conversely, if assets are less than liabilities and equity, 
the function should set short-term debt equal to zero and excess cash equal 
to the difference.
The Link Between Capital Structure Forecasts and Valuation  When using 
excess cash and newly issued debt to complete the balance sheet, you will 
likely encounter one common side effect: as growth drops, newly issued debt 
will drop to zero, and excess cash will become very large.14 But what if a drop 
in leverage is inconsistent with your long-term assessments concerning capi-
tal structure? In an enterprise DCF valuation that uses the weighted average 
cost of capital for discounting, this side effect does not matter. Excess cash 
and debt are not included as part of free cash flow, so they do not affect the 
enterprise valuation. Capital structure affects enterprise DCF only through the 
weighted average cost of capital.15 Thus, only an adjustment to WACC will 
lead to a change in valuation.
To bring the capital structure on the balance sheet in line with the capital 
structure implied by WACC, adjust the dividend payout ratio or amount of 
net share repurchases. For instance, as the dividend payout is increased, re-
tained earnings will drop, and this should cause excess cash to drop as well. 
By varying the payout ratio (both dividends and share repurchases), you can 
also test how robust your FCF model is. Specifically, ROIC and FCF, and hence 
value, should not change when the dividend rate or amount of share repur-
chases is adjusted.
How you choose to model the payout ratio depends on the requirements 
of the model. In most situations, you can adjust the dividend payout ratio 
14 Whenever ROIC is greater than revenue growth, a company will generate operating cash flow; that 
is, the investment rate will be negative. If dividends or share repurchases are not increased to disgorge 
cash, debt will drop, and/or excess cash will accumulate.
15 In the APV model, your forecast of debt will affect valuation. Interest tax shields are computed year by 
year based on the amount of debt, the interest rate, and the tax rate. Models that discount with a constant 
WACC implicitly assume debt-to-value never changes, such that balance sheet forecasts are ignored.